$7trn hazard that lies beneath M&A boom

With a bankruptcy filing looming, the Westinghouse Electric Co. nuclear business delivered one last stinging blow to Japanese parent Toshiba Corp.’s balance sheet in February: a 712.5 billion yen ($6.4 billion) goodwill writedown. But Toshiba probably won’t be the last big company to rue overpaying
for assets.
The global M&A boom has left a giant footprint on corporate balance sheets, and we’re not just talking about all that debt. Goodwill — the difference between what assets are worth on paper and how much an acquirer paid for them — is also soaring, and that could spell trouble for corporate earnings. At S&P 500 companies, goodwill has risen by two-thirds over the past decade and accounts for more than one-third of net assets.
In the past two years, takeover targets have sold for a median of 11 times Ebitda — essentially 11 years of profit — whereas the multiple was only about 7-9 times in the years leading up to the recent merger frenzy. Transactions are getting ever-bigger and more expensive, pushing total goodwill to $6.9 trillion for the companies on which Bloomberg holds data. Corporate America accounts for more than half that amount.
Companies often promise the Earth when they announce deals, so booking an impairment charge is an admission that their M&A chart-deck was too optimistic. The most common reasons are unattainable cost-cutting goals, technology becoming obsolete or a turn in the commodities cycle. The biggest danger is the lethal combination of overeager M&A bankers and impressionable CEOs.
Writedowns dent earnings and erode key credit metrics, the last thing investors need with corporate balance sheets already stretched. If goodwill on a company’s balance sheet is much higher than its market capitalization, that might be a sign that investors don’t expect to realize full value from the assets bought.
Take Community Health Systems Inc. Its goodwill is valued at more than 6 times its market value.
The US hospital operator is suffering from a case of “bad-dealitis” after its 2013 acquisition of Health Management Associates, a transaction that it’s now undoing. It’s not alone. Rival US hospital operator Tenet Healthcare Corp. has a goodwill-to-market-value ratio of 420 percent. Similarly, Valeant Pharmaceuticals International Inc.’s market value is almost five times smaller than the goodwill on its balance sheet. This exemplar of overpriced deals booked a $1.05 billion goodwill impairment in November.
As for who’s sitting on the most absolute goodwill, beer takes the cake. Anheuser-Busch InBev SA’s goodwill doubled to a cool $136.5 billion after its $100 billion takeover of SAB Miller Plc. Here’s what AB InBev’s annual
report says on the matter.
As a result of the combination, AB InBev recognized a significant amount of incremental goodwill on its balance sheet. If the integration of the businesses meets with unexpected difficulties, or if the business of AB InBev does not develop as expected, impairment charges may be incurred in the future that could be significant and that could have an adverse effect on its results of operations and financial condition.
Some folks argue that goodwill impairments don’t really matter because no cash leaves the business and
they’re inherently backward-looking. We disagree.
These types of charges signal that cash flows won’t be as strong as a company once hoped. While shareholders may see this stuff coming, they’re caught off-guard sometimes. In addition, impairments deplete shareholder equity, which makes lenders and bondholders nervous. Companies that financed takeovers with lots debt are particularly exposed.
With all this in mind, it’s only prudent for investors to do a little goodwill hunting.
— Bloomberg